Speculative Mania

By

Thomas G. Donlan

Updated Oct. 2, 2000 12:01 a.m. ET

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B uy low, sell high. That's always been the key to speculators' success in markets for anything, from carpets to vegetables. Buy something that everybody else is spurning while selling something that everybody else covets. Of course, timing is the real key to success. When should you buy low, or sell high? February 1999 would have been a good time to buy oil. At less than $10 a barrel, it was cheaper than it had been in the Great Depression. Today the same oil could be sold for more than $30 a barrel, which, while far from a record, would provide a nice profit.

We have an uncle who speculates in oil. Rarely does he do this well. In fact, our Uncle Sam bought oil when it was not so low. Uncle Sam's long-term investment in physical oil, which he calls the Strategic Petroleum Reserve, will not pay off as a speculation unless the price of oil surpasses $35 a barrel.

And that payoff point ignores adjustment for inflation and doesn't even consider the opportunity cost of income and capital gains from alternative investments. With proper adjustments for the time value of money and the value of foregone opportunities, Uncle Sam's speculation won't really come in a winner until oil goes above $70.

Created by an act of Congress in 1975 as part of the "Project Independence" fantasy that mandated a 55mile-an-hour speed limit, tax credits for solar-energy devices and fuel-economy standards for automobiles, the Strategic Petroleum Reserve was supposed to contain a supply of oil equivalent to 90 days of consumption. In 1975, that would have been 500 million barrels, but Congress was thinking strategically, so it created capacity for up to a billion barrels. Now that the U.S. consumes about 19 million barrels a day, 90 days' supply would be 1.7 billion barrels. The reserve contains 565 million barrels, about one month's supply.

Bidding to swap

Despite the downward lurch of market prices after President Clinton announced the release of 30 million barrels of oil from the Strategic Petroleum Reserve, Uncle Sam is still bullish on oil.

The deal rigged up by the Energy Department and approved by the President calls for a time swap of oil between the government and oil companies. The oil companies are to bid for the oil -- but not in cash terms. Instead they are to promise that they will put all the oil back and more. The bidders that promise to replace the most oil win the prize.

Follow the bouncing ball: Uncle Sam gives refiners oil next month and he gets more back a year from now.

The oil companies are on the bearish side of the trade and the government is on the bullish side. If Uncle Sam really expected that his actions would drive down the price of oil, he would simply sell the oil for cash and buy it back later for less.

The weight of opinion in the marketplace is against Uncle Sam. The price of oil to be delivered in the future is lower than the price of oil delivered now.

How wonderfully convenient that is for the traders arrayed against our Uncle Sam. He will give them oil which they can sell for around $30 a barrel, in return for oil delivered next year that they can buy now for around $25 a barrel. It's no wonder that our uncle can't seem to make any money speculating in oil.

An explanation for this nonsense is that Uncle Sam isn't really a speculator at all; he's a hoarder. There are people in the government who actually believe that there will someday be a shortage of oil so severe and so sudden that only oil from the Strategic Petroleum Reserve will save the national interest.

The shorthand for this dangerous situation, of course, is "war." And in time of war -- not a brief little Gulf War but a long war for national survival -- a lot of other things will happen before the U.S. makes a desperate dip into the Strategic Petroleum Reserve: gasoline rationing, mandatory thermostat settings, military allocation of electric power, reductions in "nonessential" air and rail travel. Depending on the economic advice the government receives at the time, it might even let the price go sky -- high as a means of suppressing demand.

The Strategic Petroleum Reserve creates perverse incentives. It puts the government of the United States into a position of profiting from bad policies. It can pay off only if disaster strikes.

This is a game Uncle Sam ought not to play. All his nieces and nephews ought to take him gently by the arm and steer him away from the trading pit.

That means gradually selling the Strategic Petroleum Reserve by measured quantities each month until it's all gone, then selling the storage facilities to private individuals who have the means and the guts to take the risks of speculation. Smoothing the market is a job for participants in the market, not for bureaucrats and politicians who don't even know that they are enabling their dear old uncle to ruin himself speculating.

In another game

Unfortunately, Uncle Sam's speculative mania seems to be extending itself into new markets. Last week the Federal Reserve System joined the Bank of England, the Bank of Japan and other central banks in a coordinated purchase of the euro. They took the action in hopes of arresting the slide of the currency, which went from a price of $1.17 at its inception in January 1999 to less than 85 cents recently.

Support for the euro against the dollar would relieve some of the pressure that higher fuel prices have been putting on European governments. Protests and long lines at gas stations resonate with the experience of Americans over the age of 30, who remember the energy crises of the 1970s.

If the intervention was meant to be a friendly gesture, that doesn't excuse it: As the European protestors well knew, their price of fuel is largely tax, thus largely within their governments' power to control.

It's interesting to note, by the way, that every tax has its breaking point. Europeans have endured high fuel taxes, frankly designed to reduce consumption and distort the market, ever since World War II. First the taxes were justified by appeals to economic independence, on the grounds that governments knew better than the people where their national interest lay. More recently, the fuel taxes have been justified by appeals to environmental control, on the grounds that repressing emissions of greenhouse gases is a higher national value than individual choice.

The fuel price revolt in Europe, however, is clearly a tax revolt. What a concept! It could lead almost anywhere, to a value-added-tax revolt, or an income-tax revolt, or a personal-liberty revolt.

Was this why the United States preferred to speculate against its interest by supporting the euro?

The temptation toward intervention in currency markets is probably the least appealing feature of the current international monetary regime. It is usually a speculation against reality and against one's own national interest.

Successful interventions like the 1985 Plaza Agreement, which drove down the dollar, are rare, but like the Plaza Agreement, they create more problems than they solve. The greatest danger of the small intervention in support of the euro is that it might cause investors to question the strength of the dollar.

Treasury Secretary Lawrence Summers stressed that the United States still has a strong-dollar policy, but the intervention runs counter to that. Investors are forced to wonder whether the U.S. really fears a weaker dollar, or whether -- out of all reason -- it would welcome it.

Rash promises

"You should never have to depend on the good will of the big oil companies just to heat your home or drive down the highway." Vice President Al Gore has been encouraging his audiences with the populist delusion that corporations seek power over little people.

He hopes they won't notice that power is the politician's obsession. He must know that companies, oil or otherwise, big or small, are not in business to distribute or withhold good will. They sell products and services for the highest price they can get. Good will has nothing to do with it, not even in the accounting sense.

Markets work differently. People who want to drive their cars or heat their homes have to pay the market price for fuel. Like it or not, this is a good thing, for if they don't like the price, and cut their purchases to what they can afford, the price will fall. If they do pay, they will encourage new production from sources that can be developed for less than the market price, and then the price will fall.

Even more than the price of stocks, the price of oil fluctuates. Efforts to control the price quickly lead to bigger trouble.

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